Thursday, March 22, 2012

Manufacturing’s Declining Share of GDP is Inevitable, Global, and Something to Celebrate

In a new study from the Innovation Technology and Innovation Foundation (ITIF), (“Worse Than the Great Depression: What Experts Are Missing About American Manufacturing Decline”) the authors make this statement in the introduction:

“Even if economic policy experts acknowledge that manufacturing’s share of output has declined, many comfort themselves with a narrative that such decline comes as the inevitable result of market forces. “Manufacturing is in decline everywhere, even in China,” they argue. They would be wise to consult actual data, for they would find that while manufacturing has declined as a share of GDP in some nations (notably Canada, Italy, Spain, the United Kingdom, and the United States), it is stable or even growing in many others (including Austria, China, Finland, Germany, Japan, Korea, the Netherlands, and Switzerland).”

Actually, that's not really accurate. The chart above shows the manufacturing shares of GDP for the U.S., the entire world economy and four of the countries cited in the study (Japan, Germany, Finland and the Netherlands) as having a "stable or growing" shares of GDP using United Nations data here for the years 1970 to 2010. For all five countries and for the world economy, the manufacturing shares of GDP fell to historic all-time lows in 2009, before increasing slightly in all cases in 2010. Like the U.S., manufacturing's share of GDP has fallen in Germany, Japan, Finland and the Netherlands.

It’s also interesting to note that the decline in manufacturing’s share of U.S. GDP over the last forty years (from 24% to 13%) is nearly identical to the decline in world manufacturing as a share of world GDP, which fell from 27% in 1970 to 16% in 2010. Therefore, we can conclude that the declining share of manufacturing’s contribution to GDP is not unique to America, but reflects a global trend as the world moves from a traditional manufacturing-intensive Machine Age economy to more a services-intensive Information Age economy.

The authors of the ITIF study come to a much different conclusion:

“The loss of U.S. manufacturing is not due to some inexorable shift to a post-industrial economy; it is due to a failure of U.S. policies (for example, underinvestment in manufacturing technology support policies and a corporate tax rate that is increasingly uncompetitive) and the expansion of other nations’ mercantilist policies.”

An alternative explanation is that we really are experiencing an inevitable shift to a post-industrial, Information Age economy where manufacturing’s importance to output and jobs is declining, similar to the trend in agriculture over the last century.

Manufacturing’s declining share of output isn’t a sign of economic weakness - it’s just the opposite. It’s a sign that advances in manufacturing productivity and efficiency translate into lower prices for consumers when they purchase goods like cars, food, clothing, appliances, furniture, and electronic goods. In the U.S., the price of goods relative to services fell by 52 percent between 1970 and 2010, so it’s not surprising that manufacturing’s importance in the economy has fallen significantly.

As spending on manufactured goods as a share of household income declines, it raises our standard of living, and for that “decline in manufacturing” we should celebrate, not complain.

8 Comments:

I attended yesterday's release of this report at ITIF. I thought they did a good job of arguing that manufacturing stats are flawed and that the sector is not as healthy as what the stats would suggest. However, it was never explained why the decline of manufacturing is occurring, what should be done (other than general remarks such as improving taxes, labor talent, and transportation) and -- most of all -- why we should care.

In college I worked at a factory on the assembly line during summers. It was hot, dirty and boring. That factory then closed a couple of years later. Now I work in the service sector for much higher pay and better working conditions. Not sure what the problem is that I should be worried about seeing crappy factory jobs disappear.

However, there are false prophets, with little or no economics expertise, who make a conclusion first (e.g. manufacturing is declining, inflation is high, the Fed is bad, etc.), pick a few pieces of the economics puzzle, fill in the gaps with false assumptions, and declare the picture they created is correct.

And no matter how much proof you show them it's not correct, they'll continue to defend it, perhaps just because they created it. Therefore, it has to be correct.